2.8 Market Failure - externalities + common pool resources

Question 1

Define market failure + why it occurs

Answer 1

Market failure occurs due to an inefficient allocation of resoruces. The signaliing, incentive and rationing functions of price mechanims may not always lead to a socially optimal outcome.

Question 2

Outline key terms for benefits and costs for externality diagrams

Answer 2

Marginal PB: Additoinal benefits to consumers from an etra unit output.

Marginal SB: Total benefits to society from an extra unit of output

Marginal PC: Additional costs paid by rpoducers from an ectra unit of outpout

Marginal SC: Total costs paid by society from additional unit of output

Marginal EB/EC: additional benefits or costs to third parties from extra unit of outpout

Question 3

Define market equilibrium and allocative efficiency

Answer 3

marginal cost = marginal benefit (allocative efficiency)

Market equliibrium is when allocative efficiency is achieved, social surplus maximized, no externalities.

Question 4

Outline positive externalities

Answer 4

Positive externalities: External benefits imposed to third parties through economic activities

Merit goods refer to goods associated with positigge externalities of CONSUMPTION. Due to external benefits, MSB>MPB for merit goods